It was another good week on Wall Street, primarily the result of unexpected good news in the housing and employment sectors. Our Supply Chain and Logistics stock index made the most of the optimism, especially in the transportation and logistics group.

In the software group, i2 climbed 6.7%, while both Manhattan and Oracle fell 3.2%. There wasn’t much movement in the hardware group with Intermec down 1.2% and Zebra up a very slight 0.2%. In the transportation and logistics group, Yellow Roadway soared an astounding 61.4% as union workers agreed to additional wage cuts to help save the struggling trucking company (see Good News, Bad News Scenario Continues to Plague Yellow Roadway). Others in the group with double-digit gains were Prologis (up 23.9%), Ryder (up 15.3%), and CSX (up 10.5%) after reaching a tentative 5-year extension of a wage and performance bonus package with the Brotherhood of Locomotive Engineers and Trainmen.

“Sustainability” is already having a major impact on supply chain strategies and practice – but we may only be at the tip of the iceberg (is that iceberg melting or not, as an aside?).

For now, at least in the US, the Green supply chain movement has been driven largely by the opportunity to reduce operating costs (e.g., use less fuel) and, in many cases, a public image sort of thing, however sincere a company is about their efforts. Plus the pressure from Wal-Mart and a few others.

But now, for the first real time, US companies have the specter of some kind of actual, additional cost associated with carbon emissions – and the impact there could be substantial.

A few months back, I realized that for all the talk about “cap and trade,” hardly anyone actually had much of an idea what it really meant, including me. I even recently heard a Wal-Mart Sustainability executive say much the same thing.

Gilmore Says:

"If something is actually done, there is now a real cost to carbon emissions in the supply chain, costs that are especially unpredictable with cap and trade."

(2) With that, we have also launched a new Green Supply Chain Website – TheGreenSupplyChain.com. There you will find the SCD Letter, a new, more detailed report on Cap and Trade versus Carbon Taxes, articles, white papers, news from the web and more. Take a look. It will be good.

We sub-title it “the Green Supply Chain 360°” because we are going to cover all sides of Green issues – it will have lots of news and examples, but also a variety of points of view on such topics. That balance is actually hard to find out there.

Back to cap and trade. I will do as best I can to summarize it here. A good, more in-depth description is in the Letter; even more in the report, both available at www.TheGreenSupplyChain.com.

At a high level, there are two approaches to using government policy to reduce carbon emissions: a carbon tax and “cap and trade.” While it seems most (but not all) experts believe a carbon tax would be more efficient and effective, cap and trade is the more likely of the two to be enacted in the US because it doesn’t contain the dreaded “tax” word, and, in my opinion, because legislators realize it is the one that actually gives them more power to make decisions on a continuous basis.

“Cap and trade” is by far the more complex of the two systems. It is a system that, in the end, is focused on the quantity of CO2 emissions. It would, ultimately, set a maximum of the allowable emissions in a base year and, in theory, ratchet that level down over time towards some long-term goal.

At the same time, a number of “permits” or “allowances” are created that, in total, equals that cap. They are distributed in some way (that’s where the fun begins), ranging from an auction, to free distribution, to a formula based on business type.

Because emissions are fixed, the permits begin to take on a value – and can cause some unusual things to happen. In the Cap and Trade versus Carbon Taxes report, we walk through an example in detail, but, in summary, if two companies must each reduce carbon emissions, and one can do it much cheaper than the other (let’s say Company A), then Company A may sell one of its permits to Company B, rather than use the permit is has.

Why? Say the cost for reducing its own emissions is $50,000. But perhaps the market value for a permit is now at $100,000. Maybe it would cost Company B $125,000 to reduce its own emissions internally. So, they are happy (sort of) to pay the $100,000 for a permit instead.

The key point: Company A actually netted $50,000 on the deal (it spent $50,000 internally, but sold a permit for $100,000.)

As you can imagine, all sorts of weird things can therefore happen. Just as an easy example, what if it is a brutally cold winter, and utilities and business are using a lot more energy to keep everyone warm, emitting more emissions than expected. The market price of permits could skyrocket.

A carbon tax, by contrast, is a price-based approach, rather than the quantity of emissions targeting focus of cap and trade. Under this system, a tax is placed on fossil fuel producers or importers at a rate that reflects the amount of carbon that will be emitted when the fuel is burned or used – data that is readily known across various oil-based fuels, natural gas, coal, etc.

That tax will be passed on by producers/importers in the form of higher prices. The higher prices should work in the market as a disincentive to businesses and consumers to use fossil fuels, or move to fuels that emit less CO2.

I hope I haven’t lost you yet.

Here, I believe, are several of the most important points out of this:

The Devil is in the Details: Under either program, the details can make the change a major burden and even competitive threat to businesses, or be more of just a nuisance, or somewhere in between. The details are critical – which is why a 1000-page bill that no one understands could be a disaster – or simply a waste of time (only political comment I will make here). As a simple example, at what levels would a carbon tax be set? Under cap and trade, how will permits be distributed/sold/allocated – and how will emissions really be measured? Will there be favoritism to certain industries, etc.

Depending on the Details, the Impact on Supply Chain Design and Execution Could be Substantial: If something is actually enacted, there is now a real cost to carbon emissions in the supply chain, costs that are especially unpredictable with cap and trade. On the flip side, in some cases there is even the potential for a company to profit from carbon efficiency by selling permits (some critics are actually warning of windfall profits for some companies that are basically being handed to them by the government).

So, carbon emissions and their costs would have to be directly integrated with supply chain decisions – and modeled and “scenario planned” the way many companies do now with fuel prices. What used to be the low-cost supply chain design may no longer be. And guess what – with a given SC design, you may be locking in a cost structure 10 years from now that you can’t really guess at today, as we don’t even have any law yet and the future price of permits and abatement are total unknowns.

Cap and Trade is Complex and Will Take Years to Really Move Forward: A carbon tax is far simpler, and could be enacted easily using the existing tax system. Cap and trade has many, many more moving parts, as should be clear. Lots of work for lawyers, consultants, and Wall Street types.

The Offshore Question Needs to be Dealt with: Unfortunately, the easy answer for many companies may be to stop producing products domestically – voila, a whole chunk of carbon emissions are gone. (As an aside, there could be other odd effects, like dramatically downsizing office space and more people working from home.)

India and China have both recently given mostly a cold shoulder to any notion of fixed caps for them, putting economic growth clearly as priority 1. So, we have and will get more calls for some sort of “carbon tariff,” under which we will somehow determine how much duty to add on to imported products, depending, I guess, on what country they came from and maybe even what factory. This would be to try to level the playing field versus the additional cost that US companies are bearing under cap and trade or a carbon tax. Good luck figuring that one out.

We Will be Adding Still More Complexity and Volatility Into the Supply Chain: As hopefully is clear.

There’s a lot more, but I am out of room. Hope I was able to shed some light on these critical issues. A lot more in the SCD Letter,Cap and Trade Report, and new Green site. You can count on us to give you the information you need here on all sides of the issues.

Did we add any clarity around understanding cap and trade and carbon taxes? What are some key points you would add? Do you expect the impact on supply chains to be significant? How can we plan well today with this type of uncertainty? Let us know your thoughts at the Feedback button below.

Our growing international audience made strong contributions here, including our Feedback of the Week from Canada’s Nicholas Seiersen, who pens a great letter saying Western manufacturing should be saved, but he’s not as sure it really can be.

MIT’s Esteban Guerrero says Western companies need to learn how to compete with low-cost countries more effectively, while Mark Wilkens of Edmund Optics says trade deficits by the US have to end. Consultant and educator Herb Shields says we need more focus on innovation, and Jeff Gantt of Manhattan Associates says Supply Chain Innovation can also change the dynamics. Finally, Brazil’s Daniel Druwe Araujo asks a great question about what Western countries are really doing with their time as they move up the value chain.

Each letter is excellent – take a look.

Feedback of the Week – On
Should Western Manufacturing be Saved?

As always, it is a delight to read your column.

The column on saving western manufacturing was particularly germane to the conference I was chairing in Bordeaux, the 21st annual Supply Chain Forum put on by the Bordeaux Business School’s Supply Chain MBA class. This year’s theme was re-sourcing, manufacturers bringing production back onshore. Executives in consumer goods, helicopter parts, sporting goods, and office furniture all explained their rationale for revisiting offshore sourcing.

A leading academic explained that if the China offshore price might look attractive, with labor increasing at 20%, freight increasing 400% at one time, the quality, productivity, and on-time issues… The real benefit was much less, and with the recent volatility, the bottom line is negative for many companies. So companies are indeed rethinking their offshore strategies. What made the companies that spoke at this event special was things like:

Very particular technical requirements that few suppliers in the world can meet, such as small-run, highly stressed, critical aerospace parts;

High degrees of innovation that require engineering working closely with manufacturing and/or the market to get it just right, such as fashion spectacles or high-performance bicycles;

High intellectual property content that make the risk of exposure to theft unpalatable, such as decorative products that are part of a unique style of life that is being marketed;

Quality control issues that do not translate well – Hermes red is obvious to the French, but in China, red is red;

Under-loaded manufacturing facilities that slid into greater loss when the easy-to-make, long-run manufacturing was taken out and was no longer recovering overheads; and

A requirement to fully qualify suppliers, sometimes taking 2 years to get them to a level of capability and predictable quality that is acceptable.

Add to this litany of issues the expense of managing a distant supplier with whom you do not share the same culture, and offshoring can be a very expensive proposition.

What made these companies able to bring their production back to France was that they had a sales proposition that could make room for enough margin to carry the added costs:

Fashion eyewear that requires very delicate workmanship, but that commands a premium price – you cannot find these anywhere else. They revived the traditional eyewear industry in Eastern France;

A retail franchise where customers are buying a lifestyle, not a just product;

A product that can only be made by highly qualified/regulated suppliers, where risk of loss of chain of custody or purity can render the product useless; and

Responsiveness to the market dictates proximity.

If those are the businesses that can be saved, there are also those that have already irreversibly migrated offshore, and, as you stated, the capability to manufacture has been lost. One example that comes to mind is the DVD industry, that is now dominated by offshore engineering and manufacturing – certain countries could essentially dictate the new HD technical standards, because they are the only one capable of making the equipment. Another example – golf clubs are largely made offshore. They have probably tipped beyond critical mass.

So, can Western Manufacturing be saved? Some can. Should it? Yes, absolutely, because the examples I shared with you provide unique choice in the marketplace that some are willing to pay for. The developed economies have moved away from mass-produced consumer goods, one size fits all, for some commodities.

Can Western Manufacturing be saved? Not if customers will not pay enough margin to sustain a decent return for the entrepreneurs. As I said when I was summing up the day, 21 is the age of responsibility in many cultures, the graduating class of 2009 must become aware of the reputation and the legacy they will leave behind them – as they graduate, and as they live their lives and take accountability for their choices. Some entrepreneurs are redefining the value proposition until it works. They are saving themselves.

Thoughts expressed here are not necessarily those of my employer.

Nicholas Seiersen, MBA, P.Log.

Senior Manager

KPMG

More On
Should Western Manufacturing Be Saved?:

Great points. I agree that keeping manufacturing in the US has its advantages, but the question should really be, "what is the right way?"

(A) Should the US government follow the Japanese method of "selecting" a few industries to pour its total support on? The risk would be that of protectionism, which could be counterproductive in the future.

(B) Or, should the US government put in place some kind of policies or incentives that make it attractive for US companies to maintain some manufacturing presence---or impossible to leave? The risk here would be that US cost structures could be too high to remain competitive.

Either way, it seems that the answer lies elsewhere: to become the most competitive. As the case of the Big Three has clearly shown, US companies in the long run will self-destroy if they continue to seek short-term profits instead of seeking to develop a culture (e.g., Toyota's) that ensures their long-term survival. For instance, a concept such as simple as "continuous process improvement" is eternally useful, for no matter what happens in the market place, a company that closely follows that philosophy will always have a better chance at being truly resilient.

Unfortunately, my answer implies that the solution is not around the corner. As you're well aware, it's taken Toyota decades to grow its culture, so US manufacturers must not expect to turn around their cultures in a few months or years. That's the paradox: the solution to US manufacturing today lies in US businessmens' ability to develop long-term strategies and the right organizational cultures to support them for decades to come.

Esteban A. Guerrero

MIT

If America is to recover from its current economic malaise, the United States trade deficit with the rest of the world must be reversed. Manufacturing is the most likely way to do so without lowering our standard of living. All profitable societies (Romans, Spanish, Great Britain and U.S.) have had a positive trade balance while building their wealth and empire.

For the last 30 years, unfortunately, we have been spending and borrowing on the accumulated wealth of the previous 80 years of the industrial revolution. The rising costs of manufacturing in China due to rising living standards, combined with fuel costs becoming a larger component of final consumer prices will drive more manufacturing back to the United States. The key to U.S. economic growth will become lowering energy costs and automation of production.

Mark C. Wilkins

Manager of Inventory Optimization

Edmund Optics | America

Let's not talk about "saving US manufacturing," many types of manufacturers will do quite well on their own -i.e., food, consumer products, high tech, medical devices, renewable energy, etc.

Products that can be made with low-cost labor will always chase the low-cost country; we cannot and should not try and stop that.

Where government can help is by funding R&D and education, providing support to emerging technologies and small businesses; that's where jobs get created. As you correctly point out, this process has been going on for centuries and will continue.

Herb Shields, CMC
HCS Consulting

You inspired me to finally put fingers to keyboard and write about a topic I’ve had on my white board for quite some time: ‘Have We Mis-interpreted What it Means to be Green? Globalization vs. Re-localization…The impacts to the Supply Chain Eco-System’

Should U.S./Western Manufacturing be saved?…Yes. Why? National security, job protection and product traceability for all the obvious reasons, but I believe sustainability practices holds the key. Is it going to take government policy (such as tariffs and/or carbon cap and trade policy) to compete with offshore labor costs? Quite possibly, but the true issue is product and supply chain design. As much as we in the industry like to tout that supply chains are multi-directional (or dare I say an eco-system), a majority of the world’s supply chains remain linear. Yes, returns are part of the reverse supply chain flow, but essentially, raw materials are mined/created/refined, handed off to manufacturing to create finished goods, stored, sold, consumed and then off to its final resting place…the landfill. All at a cost to the environment and enterprise.

I believe there’s a significant amount of savings on the table if supply chains and products are designed with reuse in mind. Some industries are beginning to crack that nut. Take, for instance, the carpet industry. The trend is to move towards square foot/square yard pieces, which can be individually replaced when worn or damaged, sent back to manufacturing to be melted down and resold as new carpet, all while being cost effective. Then, there’s HP’s refillable/reusable ink cartridges and returns process. Finally, The Coca-Cola Company and Coca-Cola Enterprises are both investing heavily on recovering and recycling packaging materials. For goodwill? Sure, but really for bottom-line savings.

Is it more difficult to justify when fuel is cheap? Yes, but that’s where a cap-and-trade system comes into play (which I think is inevitable policy to wean the U.S. off of foreign oil and to reduce carbon emissions). Think of the emission offset of recycling 2 billion, 20-ounce coke bottles a year. That’s a nice tax break, but the real shortcoming is comparing apples to apples. What is the true cost of doing business/manufacturing overseas (management, materials, labor, traceability, transportation/port costs, lead-times, safety-stock, and tariffs) compared to doing business/manufacturing in the U.S. (materials -reused/recycled and related carbon credits, labor, traceability, lead times, safety-stock)? Plus, with ongoing intelligent LEED facility design and development (manufacturing and distribution), these cost savings will further justify US manufacturing. TI proved this point when it built its semiconductor facility in Texas.

I must say, a few recent readings have inspired me. For a little bedtime reading, check out Natural Capitalism: Creating the Next Industrial Revolution. Why not apply these concepts to supply chain design?

Jeff Gantt

Manhattan Associates

Very good thoughts around the question - congratulations and thanks.

I would add (or reinforce, since it is said there somehow) that one should not be defending a percentage of manufacturing per se.

Yes, some manufacturing capabilities may be justified to be protected for strategic reasons, but, as a general principle, individuals and countries should continuously pursue "nobler" things to do. Things that require higher competencies and create products and services denser in value. As you correctly pointed out, this is the essence of economic progress since ever - nothing new.

Still in the 'nothing new' arena, the decay of countries has come when 'paying others to do it for you' was done not in favor of using the time for 'nobler' and more ingenuous things, but simply for laziness and self-indulgence. In other words, decay has not been historically associated so much to the evolution in the scale of 'what to do', but from the loss of love for working to generate value.

The more important question is, then, what are Western people doing with the time released from manufacturing activities. Are they using it to study more and, therefore, maintain or increase their differentiation in preparation from other countries?

Are they applying the time to innovate more and, therefore, maintaining or increasing their differentiation in technology from other countries? Are they investing their time to improve their business management practices so that they will continue ahead of other countries in the governance of the businesses, no matter where the resources are physically located?

Daniel Druwe Araujo

DAC&C Managing Partner

Brazil (in the middle of the way, gaining manufacturing activities from more developed countries and losing some to others).

SUPPLY CHAIN TRIVIA

Q.

China is poised to take over the number 1 position as top exporter over what country?